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2023 (6) TMI 1385
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....under section 143(2) was issued and served on the assessee on 24.09.2018. During the course of assessment proceedings, the case was referred to the Transfer Pricing Officer (TPO) to determine the Arm's Length Price (ALP) of the international transaction undertaken by the assessee with its Associated Enterprises (AEs). The TPO, vide order dated 28.01.2022, determined aggregate Transfer Pricing (TP) adjustment of Rs. 377,81,17,908/-. Following were the TP adjustments proposed by the TPO: i. TP adjustment of royalty amounting to Rs. 51,76,98,493/-. ii. TP adjustment towards payment of interest amounting to Rs. 326,04,19,415/-. 3. Pursuant to the TPO's order, the Draft Assessment Order was passed on 26.03.2022 by incorporating the aforesaid TP adjustment. Aggrieved by the Draft Assessment Order, assessee filed objections before the Dispute Resolution Panel (DRP). The DRP, vide its directions dated 29.12.2022, rejected the assessee's contentions. Pursuant to the directions of the DRP, the impugned Final Assessment Order was passed on 19.01.2023. The computation of income pursuant to the Final Assessment Order is as under: Business Income as per ROI (....
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....e have heard the rival submissions and perused the material on record. The assessee had benchmarked the transaction of payment of royalty by using Comparable Uncontrolled Price (CUP) method to justify the arm's length of the transaction. The assessee also benchmarked the said transaction by aggregating it to certain other transaction and by adopting the Transactional Net Margin Method (TNMM). Under both the methods, the assessee concluded the transaction to be at arm's length. The TPO rejected the methods adopted by the assessee and determined the ALP transaction at 1%. The TPO had relied on earlier Assessment Orders which was upheld by the DRP. In earlier Assessment Years, the ALP of payment of royalty was restricted to 1%. The DRP rejected the objections of the assessee by relying on the directions issued in assessee's own case for Assessment Years 2011-12 to 2014-15 and 2016-17 (refer pages 9 to 12 of DRP's directions). We find that the Tribunal on identical issue in assessee's own case for Assessment Years 2009-10 to 2016-17 and Assessment Year 2018-19 (supra) had held that the payment of royalty is to be accepted as being at arm's length. The relevant finding of the Tribunal i....
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.... asst. year 2011-12 wherein the coordinate bench of this Tribunal has allowed the appeal in favour of the assessee. 11. The ld. DR relied on the written submissions. 12. We have heard the rival submissions and perused the materials on record. We notice that the coordinate bench of the Tribunal in assessee's own case (Supra) has held that - "7.4 We have heard rival submissions and perused the material on record. The Tribunal in assessee's own case for assessment year 2009- 2010 in IT(TP)A No.315/Bang/2014 (order dated 31.03.2017) and for assessment year 2010-2011 in IT(TP)A No.361/Bang/2015 (order dated 04.06.2018) had restored the issue of determination of ALP for payment of royalty to the files of the TPO. The TPO, pursuant to the Tribunal's order, passed orders accepting the payment of royalty at 4% to be at arm's length. The relevant portion of the TPO's order for assessment year 2009-2010 reads as follows:- "3. In view of above direction of the ITAT, the assessee was asked to submit the details with respect of all comparables vide letter dated 19.06.2017. In response of the same the submission was filed by the assessee on 11.06.2017 which hav....
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....of the instant case (since the agreement for payment of Royalty is the same for earlier years and the relevant AY) we hold that the payment of Royalty at 4% is to treated at ALP. It is ordered accordingly." 9. In the relevant Assessment Year also, we find the facts are identical to the facts of the earlier Assessment Year cited supra. Therefore, we hold that the payment of royalty by the assessee is to be treated at arm's length. It is ordered accordingly. In the result, grounds 4.3 to 4.6 are allowed. 10. Payment of interest on CCDs, premium expenditure on repayment of CCDs and interest on RDBs (Ground Nos.4.7 to 4.14) (TP adjustment) During the Financial Year 2016-17, the assessee paid interest of Rs. 252,26,33,938/- on Compulsorily Convertible Debentures to Praxair Luxembourg S.A.R.L ("Praxair Luxembourg"), at interest rate of 9%, and 12%. Further, these CCDs were repurchased at a premium of 3% of the issue value. As a consideration for the repurchase/ buyback of CCDs, Praxair Luxembourg was issued RDBs/ Masala bond at Rs. 2372,39,08,630/-, on which interest amounting to Rs. 4,67,97,847/- was accrued. The assessee, in its TP study, benchmarked the transactions by applyi....
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....unds borrowed'as detailed in the TP order dated 29.1.2013. The total payment of Rs. 7,68,26,983 was treated to be at Arm's length by the appellant in its TP Study by comparing it with 4 uncontrolled comparables (though of multiple years) by CUP method. However, the TPO was of the view that the comparison with non-convertible debentures of years other than the relevant FYs was not valid comparisons and therefore, the ALP determined by the appellant on the interest paid was rejected by the TPO. Also, the TP Officer examined whether the 'interest' paid of Rs. 7,68,26,983 was in the nature of `interest' at all. The Assessing officer concluded that the CCDs were actually equity and not debt since it was compulsorily convertible to equity shares and that the Reserve Bank of India also recognised CCDs as equity instruments. Also, the TPO was of the view that the appellant had junk credit rating, having no operating income or source of cash flow to service the interest payable at 15% and that no third party would make investment in CCDs and that the arrangement amounted to this capitalisation. Holding this, the amount of Rs. 7,68,26,983 was held to be not in the nature ....
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....ejected by the Transfer Pricing Officer as detailed in the order dated 29.1.2013. ii) Whether borrowing is debt or equity; Whether thin capitalisation rules apply? The Assessing Officer has in effect held that CCDs amount to equity, and that the case is of thin capitalisation as the appellant has shown the funds as debt rather than equity although, the debt equity ratio has not been discussed in the order of the Transfer Pricing Officer. In the case of Besix Kier Dabhol, SA vs DDIT (I Tax),Circle-3(2), Mumbai, ITAT, Mumbai in their order in ITA No.4249/Mum/07 dated 20.11.2010 have held on similar facts that in absence of specific thin capitalisation rules in India, recharacterisation of debt capital as equity capital and accordingly disregarding the interest payments as tax deductables is not in order. Drawing support from the above, I hold that the conclusion of the AO that the CCDs is equity and that interest payment is not allowable cannot be upheld. i. Whether rate of interest charged is at arm's length? It is on record that the funds which have been raised by the appellant through CCDs and have been utilised for the business of the appel....
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....tment being given to the equity capital and debt capital being fundamentally different, it is often more advantageous in international context to arrange financing of a company by loan rather than by equity. It does affect the legitimate tax revenues of the source country in which business is carried out because while dividends and interest are generally taxable at the same rate in the hands of the recipient in the source country, e.g. under India Belgium tax treaty WHT rate on interest, other than bank interest, as also dividend is at uniform 15 per cent, interest is tax deductible and that results in lower corporate taxes in respect of PE profits. These tax benefits could be further optimized by hybrid financing instruments such as profit participating loans, convertible loans or where instrument is treated as debt in the source country of the income (i.e. resulting in tax deductible interest) and as equity in the residence country of the lender (i.e. where lender may claim the participation exemption of interest income because of its characterization as distribution of profits). That is how tax considerations at times do result in a company being too thinly capitalized, or, to p....
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....d on the debt. Interest relating to debt in excess of this ratio is considered a non-deductible business expense [art. 198(11) IR/WIB]. In a 2008 IBFD publication "International Tax Planning and Prevention of Abuse" (by Dr Luc De Broe . ISBN 978- 90-8722-035-08; @ p. 502), these thin capitalization rules are summed up as follows . "Belgium has five domestic law provisions that are relevant for the discussion of thin capitalization, i.e. art. 26 BITC; art. 54 BITC; art. 198, 11° BITC, art. 18, 4° BITC and the Belgian GAAR. Articles 26, 54 and 198 belong to the first group of aforementioned rules. The deduction of interest is denied if the statutory conditions for deductibility are not satisfied. Articles 26 and 54 are not concerned with the question whether the borrower is undercapitalized but only whether the interest charged is at arm's length. Excessive interest (i.e. interest charged above the prevailing market conditions) is not deductible. Article 198, 11° is concerned with undercapitalized companies. Interest is not deductible if the statutory 7 . 1 debt/equity ratio is exceeded. Article 18, 4° BITC belongs to second group of aforementioned rules; it ....
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.... borrowings, which can be attributed to thin capitalization rules, in India. 23. The question then arises whether even in the absence of any specific thin capitalization rules in India, it could be open to the Revenue authorities to recharacterize the debt capital as equity capital and, accordingly, disregard the interest payments as tax deductibles. 24. We find guidance from Hon'ble Supreme Court's judgment in the case of Union of India & Anr. vs. Azadi Bachao Andolan & Anr. (2003) 184 CTR (SC) 450 . (2003) 263 ITR 706 (SC) wherein their Lordships have, inter alia, observed as follows . "111. In para 3.3.1 after noticing the growing practice amongst certain entities, who are not residents of either of the two Contracting States to try and avail of the beneficial provisions of the DTAAs and indulge in what is popularly known as 'treaty shopping', the report says . '3.3.1 ..there is a need to incorporate suitable provisions in the chapter on interpretation of DTAAs, to deal with treaty shopping, conduit companies and thin capitalization. These may be based on UN/OECD Model or other best global practices.' 112. In para 3.3.2 the working gr....
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....e in the DTAA, that provision will prevail over the general provisions contained in the IT Act, 1961. In fact the DTAAs which have been entered into by the Central Government under s. 90 of the IT Act, 1961, also provide that the laws in force in either country will continue to govern the assessment and taxation of income in the respective country except where provisions to the contrary have been made in the agreement." 27. In the case of UCO Bank vs. CIT (1999) 154 CTR (SC) 88 . (1999) 237 ITR 889 (SC), their Lordships of Hon'ble Supreme Court had an occasion to survey the judicial precedents on the question of binding nature of the CBDT circulars. After elaborately dealing with Hon'ble Supreme Court's judgments in the cases of Navnit Lal C. Jhaveri vs. K.K. Sen, AAC (1965) 56 ITR 198 (SC) and K.P. Varghese vs. ITO & Anr. (1981) 24 CTR (SC) 358 . (1981) 131 ITR 597 (SC), their Lordships concluded that the CBDT circulars inter alia can tone down the rigour of the law and such benevolent circulars are binding on the field authorities. It cannot therefore be open to a Revenue authority to disregard the CBDT circular even if it deviates from the law-as long as it is beneficia....
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....to in the Twentieth Schedule, shall apply to the assessee referred to in sub-s. (8), whether or not such provisions are beneficial to him". The treaty override is thus quite restricted in scope in this new paradigm. Unlike in the proposed code and in sharp contrast to this paradigm, the treaty override in the IT Act, 1961, save and except for the higher tax rate being permitted for the foreign companies, is unqualified. In the scheme of things, as it exists in the Indian IT Act, 1961, the treaty override over domestic law is much wider in scope. We cannot interpret the treaty provisions in such a manner so as to curtail, dilute or otherwise tinker with this comprehensive treaty override over the domestic tax law. 29. It is also important to bear in mind that when there are no thin capitalization rules vis-a-vis domestic thin capitalization situations and in the light of the s. 90(2) as it exists at present any attempts to neutralize thin capitalization vis-a-vis PEs of Belgian enterprise will be clearly contrary to the scheme of non-discrimination envisaged by art. 24(5) which provides that, "enterprises of a Contracting State, the capital of which is wholly or partly-owne....
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....ticularly in view of Explanation to s. 37 being confined to the amounts admissible as deduction under s. 37, does not render the interest paid by the assessee as not deductible, and it is not even necessary to examine the scope of Explanation to s. 37. It is also quite possible that tax considerations may have played a role in assessee's planning the capital structure, but an element of planning in structuring capital does not transform a taxdeductible expense of interest into an expense that is non-tax deductible. In view of these discussions, it is clear that the impugned disallowance is indeed contrary to the scheme of the law as it exists; the grievance of the taxpayer deserves to be upheld. We, therefore, direct the AO to delete the impugned disallowance." 23. As per above paras of this tribunal order, it comes out that even if Thin capitalization Principle is on Statute book of the other country, no disallowance can be made in India by applying this Principle. To this extent, we uphold the finding of CIT (A) by respectfully following this tribunal order. But the issue still remains because, the objections of AO/TPO are not merely on the basis of Thin capitalization P....
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....nting to Rs. 61,50,22,027. In the TP study, the assessee benchmarked the transaction of payment of interest by applying CUP method. Using the CCD benchmarking study, the assessee selected two companies as comparables and since the arithmetical mean of interest paid by the two companies stood at 9.5%, the assessee concluded the international transaction of payment of interest at 9% to be at arm's length. 8.1 The TPO treated the CCDs as External Commercial Borrowings (ECB) and benchmarked the interest rate paid against LIBOR rate of 4.13% (being LIBOR + 350 basis points). (Refer page 25 to 29 of the TPO's order). 8.2 Aggrieved, the assessee filed objections before the DRP. The DRP rejected the assessee's objections and upheld the TPO's order (refer pages 3 and 4 of the DRP's directions). 8.3 Aggrieved, the assessee has raised this issue before the Tribunal. It is submitted that the TPO and DRP grossly erred in treating the CCDs as ECBs and benchmarking the interest rate against LIBOR rate. It was submitted that CCDs being a hybrid instrument, cannot be treated as an ECB/loan. Reliance in this regard is placed on the order of the Hyderabad Bench of the Tribu....
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....wn by the Coordinate Benches and the Hon'ble High Court as relied on by the assessee in the submissions, we have to hold that TPO has wrongly treated the issuance of CCDs as a loan, by treating it as an external commercial borrowing, ignoring the fact that loan is a debt, whereas CCD is hybrid instrument in nature basically categorised as equity in nature. It was accepted by the Hon'ble Supreme Court in the case of Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation Limited & Ors. Vs. Securities and Exchange Board of India & Anr. in Civil Appeal No. 9813 of 2011 dt. 31-08-2012 (supra) while assigning the jurisdiction to SEBI as an 'equity instrument'. Further, the policy of Govt. of India and also RBI effective from 01- 04-2010 also indicate that issuance of CCD is part of FDI being quasi-equity in nature and considering the same as a loan would be completely against regulations laid by DIPB, RBI and FEMA. It is to be reiterated that issuance of CCDs was denominated in Indian Rupees and not foreign currency. Therefore, TPO has erred in considering LIBOR as benchmark rate which is in complete contradiction to the principles on the issue. Th....
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....ncy concerned. The rate of interest on a US $ loan is the same in New York as in Frankfurt-at least within the framework of free capital markets (subject to the arbitrage). In regard to the question as to whether the level of interest rates in the lender's State or that in the borrower's is decisive, therefore, primarily depends on the currency agreed upon (BFH BSt.B 1. II 725 (1994), re 1 § AStG). A differentiation between debt-claims or debts in national currency and those in foreign currency is normally no use, because, for instance, a US $ loan advanced by a US lender is to him a debt-claim in national currency whereas to a German borrower it is a foreign currency debt (the situation being different, however, when an agreement in a third currency is involved). Moreover, a difference in interest levels frequently reflects no more than different expectations in regard to rates of exchange, rates of inflation and other aspects. Hence, the choice of one particular currency can be just as reasonable as that of another, despite different levels of interest rates. An economic criterion for one party may be that it wants, if possible, to avoid exchange risks (for example, ....
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.... repayment is to be made. The same principle should apply." 8.6.3 In the instant case, admittedly, the CCDs are issued in INR, interest is paid in INR and CCD's are repaid also in INR. Therefore, placing reliance on the judgment of the Hon'ble Delhi High Court in the case of CIT v. Cotton Naturals (I) Pvt. Ltd. (supra), we hold that the TP study of the assessee to justify the interest rate by arriving at average rupee cost and comparing the same with SBI prime lending rate is correct. It is ordered accordingly. 8.6.4 Hence, ground 4 is allowed." 5.3 Further, in assessment year 2012-13 in IT(TP)A No.2209/Bang/2016 vide order dated 25.2.2022 the Tribunal has held as under: 14. "The next issue is the adjustment made by the TPO with regard to payment of interest on compulsory convertible debentures (CCDs) by recharacterizing the same to be External Commercial Borrowings (ECB). 15. The Ld.AR submitted that this issue is also covered in assessee's own case (supra) wherein the coordinate bench of this Tribunal has allowed the appeal in favour of the assessee. 16. The ld.DR supported the decision of the lower authorities. 17. W....
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....diction to SEBI as an 'equity instrument'. Further, the policy of Govt. of India and also RBI effective from 01- 04-2010 also indicate that issuance of CCD is part of FDI being quasi-equity in nature and considering the same as a loan would be completely, against regulations laid by DIPB, RBI and FEMA. It is to be reiterated that issuance of CCDs was denominated in Indian Rupees and not foreign currency. Therefore, TPO has erred in considering LIBOR as benchmark rate which is in complete contradiction to the principles on the issue. The following judicial precedents supports that the rate interest has to be considered in the currency in which loan has originated. i. India Debt Management Pvt. Ltd., IT(TP)A No. 7518/Mum12014; ii, CIT Vs. Cotton Naturals (I) Ltd., ITA No. 23312014 (Deli-HC); iii. M/s. Brahma Center Development Pvt. Ltd., Vs. [TO, ITA No. 3 73/Del/2016 (ITA T Del). By respectfully following the Co-ordinate Bench and Hon 'ble High Court decisions, we agree with the assessee 's contentions that the CCDs cannot be categorised as a loan and LIBOR plus two hundred basis points benchmark cannot be accepted on the facts of the case." 8.6.2 The Hon....
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....eign currency debt (the situation being different, however, when an agreement in a third currency is involved). Moreover, a difference in interest levels frequently reflects no more than different expectations in regard to rates of exchange, rates of inflation and other aspects. Hence, the choice of one particular currency can be just as reasonable as that of another, despite different levels of interest rates. An economic criterion for one party may be that it wants, if possible, to avoid exchange risks (for example, by matching the currency of the loan with that of the funds anticipated to be available for debt service), such as taking out a US $ loan if the proceeds in US $ are expected to become available (say from exports). If an exchange risk were to prove incapable of being avoided (say, by forward rate fixing), the appropriate course would be to attribute it to the economically more powerful party. But, exactly where there is no 'special relationship', this will frequently not be possible in dealings with such party. Consequently, it will normally not be possible to review and adjust the interest rate to the extent that such rate depends on the currency involved. Mo....
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....arrive at the interest rate of 9% and 12% calculated based on the average rupee cost comparing the same with SBI prime lending rate. The assessee's claim in this ground is allowed." 5.4 Further, in assessment year 2013-14 in IT(TP)A No.2839/Bang/2017 vide order dated 25.8.2022, wherein it was held as under: "Grounds 16 to 21 [TP adjustment of Rs. 67,08,42,381 on payments of interest on Compulsory Convertible Debentures (CCDS)] 18. Grounds 16 to 21 in respect of Compulsory Convertible Debenture (CCD), reads as follow:- "16. The Hon'ble DRP / learned TPO has erred in rejecting the transfer pricing analysis undertaken by the Appellant in the transfer pricing documentation to determine the arm's length nature of the international transaction pertaining to payment of interest on CCD and thereby erred in making an addition of Rs. 67,08,42,381/- to the total `of the Appellant. 17. The Hon'ble DRP has erred in upholding the contentions of the learned TPO of re-characterizing the CCD to External Commercial Borrowings ("ECB") by not appreciating the fundamental difference between a CCD and an ECB and thereby erred in applying the 6 Month US Lon....
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....he DRP's directions). 20. Aggrieved, the assessee has raised this issue before the ITAT. The learned AR submitted that the TPO and DRP grossly erred in treating the CCDs as ECBs and benchmarking the interest rate against LlBOR rate. It was submitted that CCDs being a hybrid instrument, cannot be treated as a ECB/loan. In this context, the learned AR relied on the decision of the Hyderabad Bench of the Tribunal in the case of ADAMA India (P.) Ltd. v. DCIT ([2017] 78 taxmann.com 7 (HyderabadTrib.). It is submitted that the CCDs having been denominated in INR the interest having been paid in INR, and the CCDs having been repaid in INR the same cannot be benchmarked against LlBOR. Reliance in this regard is placed on the following decisions: (i) CIT v. Cotton Naturals (I) (P.) Ltd. ([2015] 55 taxmann.com 523 (Delhi) (ii) Assessee's own case for the assessment year 2012-13 (Order date 25.02.2022 passed in IT(TP)A No.2209/ Bang /2016). Therefore, it is submitted that the transaction of payment of interest of CCDs ought to be treated as being at arm's length. 21. The learned Departmental Representative supported the orders of the TPO and DR....
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....tegorised as equity in nature. It was accepted by the Hon'ble Supreme Court in the case of Sahara India Real Estate Corporation Limited and Sahara Housing Investment Corporation Limited & Ors. Vs. Securities and Exchange Board of India & Anr. in Civil Appeal No. 9813 of 2011 dt. 31- 08-2012 (supra) while assigning the jurisdiction to SEBI as an 'equity instrument'. Further, the policy of Govt. of India and also RBI effective from 01- 04-2010 also indicate that issuance of CCD is part of FDI being quasi-equity in nature and considering the same as a loan would be completely, against regulations laid by DIPB, RBI and FEMA. It is to be reiterated that issuance of CCDs was denominated in Indian Rupees and not foreign currency. Therefore, TPO has erred in considering LIBOR as benchmark rate which is in complete contradiction to the principles on the issue. The following judicial precedents supports that the rate interest has to be considered in the currency in which loan has originated. i. India Debt Management Pvt. Ltd., IT(TP)A No. 7518/Mum12014; ii. CIT Vs. Cotton Naturals (I) Ltd., ITA No. 23312014 (Deli-HC); iii. M/s. Brahma Center Development....
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....therefore, primarily depends on the currency agreed upon (BFH BSt.B 1. II 725 (1994), re 1 § AStG). A differentiation between debt- claims or debts in national currency and those in foreign currency is normally no use, because, for instance, a US $ loan advanced by a US lender is to him a debt claim in national currency whereas to a German borrower it is a foreign currency debt (the situation being different, however, when an agreement in a third currency is involved). Moreover, a difference in interest levels frequently reflects no more than different expectations in regard to rates of exchange, rates of inflation and other aspects. Hence, the choice of one particular currency can be just as reasonable as that of another, despite different levels of interest rates. An economic criterion for one party may be that it wants, if possible, to avoid exchange risks (for example, by matching the currency of the loan with that of the funds anticipated to be available for debt service), such as taking out a US $ loan if the proceeds in US $ are expected to become available (say from exports). If an exchange risk were to prove incapable of being avoided (say, by forward rate fixing), th....